Falling Oil Prices: Possible Scenarios |
Al Hayat - 11 June, 2012
Author: Walid Khadduri
Crude oil prices have fallen recently from about $ 128 per barrel to about $ 100 at present. This is due to two main reasons: Increased pessimism with regard to the future of the world economy, and the considerable rise in U.S. commercial crude oil inventories.
Concerns about the global economy stem from the escalating sovereign debt crisis in Europe, first in Greece and now in Spain, with the possibility of contagion in Italy and Portugal, and with this effectively leading to a contraction in demand for oil. In addition, there is a cautious sentiment as the date for the Western sanctions on Iranian oil exports to come into effect draws near (July 1st if the talks in Moscow over the Iranian nuclear program were to fail).
The sovereign debt crisis in Europe caused a rapid slide in oil prices, with its risks including the possibility of a Greek exit from the Eurozone, and the accumulation of huge debts by Spanish banks and questions about how these will be repaid. All this has exacerbated fears of the European crisis spreading further inside the Eurozone and the European Union, and then globally, putting pressure on demand for oil and pushing it further down.
Furthermore, there is concern in the markets over the Chinese economy, especially with the release of recent data showing a slowdown in economic output and domestic consumption, following negative data throughout the past two months (April and May). A slowdown of the Chinese economy, as is known, would have a much more dramatic effect on global demand for oil than any economic contraction in Europe. Nevertheless, despite the negative data coming from China so far, the shrinking demand for oil is mainly due to government policies aimed at curbing inflation, and which have reduced industrial output and negatively affected investment policy in the industrial sector. However, pundits expect China to change its deflationary policy during the second half of this year, and anticipate, therefore, that energy consumption would rise back to its previous levels (i.e. an annual growth rate of around eight percent), which will no doubt leave its mark on the international oil markets by the end of the year.
Other developments that fueled concern in the markets as well include reduced demand for gasoline in the United States (the highest in the world), which did not increase at the start of the present season of summer holidays beyond nine million barrels per day – a relatively low level of demand. This is while gasoline prices in U.S. markets hovered around relatively high levels (around $ 4 per gallon).
Naturally, we cannot assess the oil markets in 2012 without taking into account sanctions on Iranian oil, which forced major producers in the Gulf to tap into their spare productive capacities to offset lost Iranian imports for European and Asian consumers. This increase in oil output, in tandem with the decline in demand, has led to the current decline in prices. However, it must be recalled here that the price level of $ 128 per barrel was not a natural price at the time, and one that did not reflect market fundamentals of supply and demand. For one thing, prices had risen because of fears of a halt in Iranian oil exports, and speculation which only increases during crisis, as well as the false belief, promoted by some, that major producers in the Gulf would not be able to offset the shortage in global oil supplies.
So what trend are prices expected to follow in the future? Previous experiences highlight the fact that it is extremely difficult to curb the deterioration of oil prices when they begin to slump. To be sure, OPEC member states suffered greatly during the Asian economic crisis of 1998, and also during the American economic crisis in 2008. In both cases, OPEC could only halt the deterioration of prices after a relatively long period had passed, and only after the producing countries had endured huge losses. However, the producing countries have been reiterating on a weekly basis their satisfaction with a price level of around $ 100 per barrel, on the grounds that this is advantageous to both producers and consumers, and despite the fact that the International Energy Agency has repeatedly said that the $ 100 price is too high and extremely harmful for the global economy, as it undermines its recovery from the global crisis.
But since the spare productive capacities are controlled by the major oil producers in the Gulf, which have confirmed their satisfaction with the price of $ 100, and most importantly, since the economies and budgets of these countries need a price of $ 100 to cover the high salaries and subsidies offered to their citizens – for example on electricity, water and fuel costs-, it is expected that the $ 100 price level will be maintained.
Yet most importantly, the issue of the Iranian nuclear program remains unresolved, with an ongoing boycott of Iranian oil, an essential part of the negotiations between the West and Iran. In other words, the Western countries are willing to maintain these sanctions for a long period of time until they verify -if that is at all possible-, that the Iranian nuclear issue has been resolved.
Of course, should there be a failure to reach a diplomatic solution with Iran over its nuclear program, then there is a possibility of resorting to the military option to resolve this issue. In this case, an emergency situation should be expected, given the implications of a decision of this kind. It is difficult to draw up a scenario of the repercussions of such a decision on the security of oil supplies from the region, or oil prices which usually rise during emergency situations.
*. Mr. Khadduri is a consultant for MEES Oil & Gas (MeesEnergy)